When Stocks and Bonds Yield Nothing

How to Make Your Money Work Harder

Historically, there have been times when the stock market's dividend yield was low. Historically, there have been times of modest bond yields. What's unusual about today? We have both at the same time -- and that puts investors in a tough spot.

Charles Farrell, chief executive of Denver's Northstar Investment Advisors, calculates that a portfolio split evenly between the S&P 500 and intermediate-term government bonds would have generated 1.67% in income last year and a projected 1.85% this year, versus a 4.3% average for the period since 1925. His numbers are based on data from Ibbotson Associates, a unit of Chicago investment researchers Morningstar.

Because both stocks and bonds are kicking off less income, "you're going to have to work a lot harder to make your money grow," Mr. Farrell reckons. He estimates that, over the next decade, a portfolio split evenly between stocks and bonds might have a total return -- income plus price gains -- of around 2 to 2.5 percentage points a year more than inflation.

With inflation at 2.1% over the past 12 months, versus a 3% historical average, today's low stock and bond yields aren't quite as alarming as they seem. "Even then, both markets may be 30% or more overvalued from a cash-flow standpoint," Mr. Farrell says.

Skimpy yields. Low bond yields are obviously worrisome. Intermediate-term Treasurys, as represented by the five-year note, are currently yielding 1.8%. You are getting scant income, the yield is below the inflation rate, and you could suffer nasty short-term losses if interest rates spike higher.

What about stock yields, currently 1.9% for the S&P 500? Investors seem less perturbed, partly because companies have been aggressively buying back stock, which is another way to return money to shareholders.

Over the past decade, companies have bought back roughly enough shares to offset new issuance. That's a change from the historical pattern, when shareholders collectively saw their stake diluted by some two percentage points a year. But it isn't clear whether the pace of buybacks will continue. Companies have been using spare corporate cash to repurchase shares, in part because they've been reluctant to make large capital expenditures, but today's low capital expenditures may not be sustainable. Moreover, the timing of these buybacks has been dreadful. Companies were big buyers of their own stock as the 2007 market peak approached, then cut back sharply during the collapse of 2008 and 2009, and now are again buying heavily.

Stock investors also seem less concerned about tiny dividend yields because they have grown used to creating dividends by selling shares. "With stocks, people say, 'Who cares about income? I can make it up with capital gains,' " Mr. Farrell says. "But the more you're dependent on capital gains, the more volatility you'll deal with."

Indeed, in falling markets, no-dividend stocks tend to get hammered, while higher-yielding shares often hold up better. That goes to a more fundamental issue: To make money from a company that never returns cash to shareholders, you're dependent on someone else coming along and paying more for your shares than you did.

Defensive measures. With both stocks and bonds expensive, investors will find it tough to escape low returns. So what should they do?

Mr. Farrell advises paying down debt. Suppose you have a mortgage costing 5%. That seems like cheap money. But the rate is likely higher than the yield on your bonds, so it may make sense to sell bonds to pay down your home loan.

And your portfolio? If you hold down investment costs and minimize your investment-tax bill, you should keep more of whatever the markets deliver. In addition, there's the obvious: Save more.

"If you have a $500,000 portfolio with a 4% yield, you're adding $20,000 every year from the portfolio's income production," Mr. Farrell notes. "But if it's yielding just 2%, you're only adding $10,000 a year. To compensate, you need to save more and you might want to favor stocks that will give you more income."

Mr. Farrell suggests reducing risk on the bond side, by sticking with shorter-term, higher-quality bonds, while putting more into stocks, including companies that regularly raise dividends. "You might use the bonds to play defense, while taking risk on the stock side," he says. "The better risk-reward trade-off right now is in stocks."

If you buy strong dividend-paying stocks, you might defeat "inflation creep" by rising along with it. Utilities, for example - They charge in the $$$s of the day, profit in the $$$s of the day, pay dividends out of their profits of the day at the value of the $$$s of the day. I did not see, thus far, mention of U.S. Treasury TIPS which have yields that match the nation's market basket's total cost in $$$s of the day. While inflation seems insignificant now, compound the 3% or so it diminishes a nest egg year after year. oOo

Wow. This guy doesn't have very good ideas. Look you can buy a dozen high quality dividend paying companies yielding 3.5 or more. You can buy intermediate tax free funds yielding 3%. You can buy intermediate high grade corps yielding 4.5%

Some good bond funds have provided more yield over the past couple of years. A mix of high quality muni, foreign, domestic and some high yield funds can provide a yield above 5%. However, the Fed is to be blamed. In a previous administration, banks would pay 4.25% larger balance savings accounts.

Another way to save money not mentioned here is to make sure the fee's you pay an adviser ( if applicable) are also adjusted down. In other words if returns are down why would you pay the same to an adviser to get less? Most people pay far more for then they think and most managers cannot beat an index. Companies like Guardvest.com were created so that people could get the whole story on what they pay and what they get for that fee. It is estimated by the WSJ that investors overpaid for advice by $250 billion last year alone. Cutting the fee's you pay for money management is a real easy way to save money and less painful then paying off debt. Its a no brainer to cut those costs unless the returns can justify the fee

Why do you think municipal bonds have to pay interest at a rate that is so much higher than the market rate of return on other bonds? When did the spread increase and why did the spread increase. Look-up "Laurie Goodman".

Bad data produces bad decisions. Best 'defense' is to buy longer maturity bonds. Twenty year muni maturities will yield nearly 5% and corporates just over 5%, much higher than the short term bonds. Thus you are giving up 3% per year while you 'wait' for interest rates to rise so that you can buy longer issues. In practice you will probably just continue waiting. Note this holds if you buy individual bonds and hold to maturity. Anybody buying a bond fund now is insane.

low interest rates are required by the current admin, in order to "fund" the massive public spending of the last 6 years. Senior citizens are getting hammered by these low rates - and at the same time, they were a key part of helping vote in this admin,

Why do these "experts" never discuss municipal bonds? Returns in the 5 to 6% range tax free with little or no risk, especially in a municipal bond fund. With CDs paying nothing and treasurys almost as bad, munis appear to be the best safe play. If anyone has a better idea I would like to hear it.

I had forgotten all about the low yields of stocks and bonds. I guess being overweighted in pipeline master limited partnerships is paying off. If you believe that the shale boom is for real, then you can still get 6 or 7 percent yields on good quality MLPs. That's also if you believe that MLPs are for real. I do.

I overlay the painful inflationary 70's on our times now. That episode was allowed to go for years before anyone at the Fed had the courage to do something (Paul Volcker). Fast forward to today...the legacy of Bernanke and Yellen is likely to set up a similar scenario, after they're long gone. The fact is inflation is much higher for us Main Streeters than our liars in Washington let on. So what do we do? We're in for a long and painful slog. Interest rates will only gradually rise over a period of years, while inflation continues to eat savers and small investors alive. I pursue a bunker mentality, trying to save every nickel I can and still keep working as I approach my mid-70's. Despite the Fed's efforts to ruin the value of our hard-earned bucks, I have no alternative but to amass cash and hope for better times.

"Pay down debt" was the best advice. I say forget about traditional investments in the face of QE debauchery of the bond and stock markets, a Marxist revolutionary for president, and national debts and liabilities beyond catastrophic levels. I tell my friends: farm, long-storage food, independent water supply, gold, silver, ammo, medical gear, teamwork, tools and spare parts for everything. I call it, "Be an Amish farmer-machinist NRA member." If I'm right or wrong, "goodness, strength, and independence, anyway."

The current practice of companies buying back stock instead of paying dividends is a great injustice. Often they buy back stock to avoid diluting ownership after stock options are exercised. In doing that, they will often buy at market highs. They need to eliminate stock options, and simply pay their executives a decent salary, while paying their stockholders dividends. The stockholders could then use their dividends for whatever purpose they wish, including buying stock in other companies to diversify. The idea of buying back stock instead of paying dividends is a lousy idea under any circumstances.

Because the average investor is married, has 2 kids, has a household income of roughly $50,000, a mortgage, and a single digit effective tax rate after deductions. If they are 50, they have $50,000 saved for retirement. Also, Cap gains if you are in the 10-15% brackets is 0%. They have no use for municipal bonds because they give up more yield than they save in taxes especially since they are probably buying investments in a 401(k) or IRA.

Also, if you are looking at muni's with a yield of 5-6%, you are looking a junk bond credit ratings. They are always *safe* until the day they default. Ask Detroit.

@Harold Lampi good solid classical advice. if we survive bonds will rally, rates will tick up and we can get back to traditional mixes. having a few mlps helps until they pay out. what we need is october 2014 and november 2016 to get here toute suite.

There is another alternative: stay with your historical bond/stock allocation, but just adjust your return expectations from the historic 10% to 6% or lower. Sure, you'll be there if the market crashes, but if you hold on you'll still most likely come out ahead of cash (i.e. 0% ) in the long term.

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